End of Uttarakhand sops to automakers with plants in the state may hit Hero, Bajaj badly

Auto stocks have fallen 15-25% in the past three months due to regulatory disruption such as the ban on registration of diesel vehicles, infrastructure cess of 1-4% in the Budget and the government’s plan to implement tighter emission norms.Ashutosh Shyam | ET Bureau | March 15, 2016, 08:09 IST

The phasing out of excise tax incentives for manufacturing plants in Uttarakhand in the next two years may emerge as an additional regulatory headwind for the auto sector.

Auto stocks have fallen 15-25% in the past three months due to regulatory disruption such as the ban on registration of diesel vehicles, infrastructure cess of 1-4% in the Budget and the government's plan to implement tighter emission norms.

The phasing out of the excise duty benefits in Uttarakhand may lead to operating margin compression in the range of 50-100 bps for M&M, Bajaj Auto and Hero MotoCorp.

Their projected earnings may dwindle by 5-10% for FY17. Uttarakhand units contribute 12-30% to the production of these companies.

Margin expansion was the prime factor that boosted earnings growth in the nine months to December 2015 for automakers. Hence, any softness in the margins means that volume growth will become crucial for earnings growth. This may lead to churn in the auto companies' portfolio.

For instance, the gap between Maruti Suzuki's price-earnings (P/E) multiple and that of Hero and M&M has narrowed in the past three months. The gap may increase again as investors start pricing in additional headwinds.

M&M in a recent analyst call indicated that company's margins will drop by 100 bps in the fourth quarter due to the phasing out of the incentives at Haridwar plant.

The extent of the margin contraction was greater than street expectation, and it resulted in the earnings cut by 6-8% for the next two fiscal years.

Credit Suisse downgraded the stock to neutral rating. The plant accounts for 15% of the total volume of the company.

The volumes from Uttarakhand plant for Hero Moto is nearly 30% of the total revenue and one-third of the profit of the company. Thus, its earnings growth is most vulnerable.

Bajaj Auto earns 15% revenue from its plant in Uttarakhand. The tax incentive is expiring for Hero Moto and Bajaj Auto in March 2018 and March 2017, respectively.

Given slower demand growth, companies may find it difficult to pass on the increased tax.

In the nine months to December 2015, aggregate revenue of nine auto companies grew by 12% year-on-year, while operating profit rose 50%.

In the absence of margin growth, dependence on the volume growth will increase considerably.

Prices of most SUVs were cut between Rs 1.1 lakh and Rs 3 lakh following the implementation of GST, which subsumed over a dozen central and state levies like excise duty, service tax, and VAT from July 1.